Thursday, June 23, 2011

Hayek and the Myth of Neutral Money

Hayek’s version of the Austrian trade cycle theory adopted the Wicksellian notion of “neutral money.” This appears to have been one of Hayek’s fundamental ideas in developing the trade cycle theory, and he presents his case for neutral money as a concept in a 1928 essay:

The extent to which Hayek urged neutral money as a actual monetary policy is unclear. But, as late as 1933, Hayek appeared to be still urging the idea of attempting to make money neutral (or, that is to say, trying to implement monetary policy that would approach the situation of “neutral money”), though he is not as optimistic about it:

Hayek had already come up against the critique of Sraffa in 1932 and by the time of the 2nd edition of Prices and Production (2nd edn; Routledge and Kegan Paul, 1935) he was starting to distance himself from neutral money, and admitting it was never a practical monetary policy.

And by the time of Denationalisation of Money: The Argument Refined. An Analysis of the Theory and Practice of Concurrent Currencies (1990; 1st edn 1976), Hayek is quite clear that any attempt to create neutral money in the real world is pointless:

“Although I have myself given currency to the expression ‘neutral money’ (which, as I discovered later, I had unconsciously borrowed from Wicksell), it was intended to describe this almost universally made assumption of theoretical analysis and to raise the question whether any real money could ever possess this property, and not as a model to be aimed at by monetary policy. I have long since come to the conclusion that no real money can ever be neutral in this sense, and that we must be content with a system that rapidly corrects the inevitable errors.” (Hayek 1990: 87–88).

Sraffa is vindicated:

“The starting-point and the object of Dr. Hayek’s inquiry is what he calls ‘neutral money’; that is to say, a kind of money which leaves production and the relative prices of goods, including the rate of interest, ‘undisturbed,’ exactly as they would be if there were no money at all. This method of approach might have something to recommend it, provided it were constantly kept in mind that a state of things in which money is ‘neutral’ is identical with a state in which there is no money at all: as Dr. Hayek once says, if we ‘eliminate all monetary influences on production ... we may treat money as non-existent’” [Prices and Production, p. 109]. .... (Sraffa 1932: 42).